Geopolitics of Energy Into the 21st Century

The message I want to bring to you today is a simple one, but one that carries tremendous financial and geopolitical implications. The message is this:

It is perhaps ironic that in an age where the pace of technological change is almost overwhelming, the world will remain dependent, for this decade and next at least, on essentially the same forms of energy -- oil, coal, and natural gas -- that fueled the 20^th century.

But as the coming years play out, major shifts are afoot. By the year 2020, or perhaps sooner, energy consumption by the Developing World is expected to surpass that of the Industrialized World. What forms of energy will these countries be consuming -- cheap, dirty coals or clean natural gas, for example -- and where will the supplies come from? Will this shift lead to competition -- both economic and political -- for access to supplies? Can these countries pay for the energy and supporting infrastructure, such as power-generating plants, or will the Industrialized World have to help out with funds and with technology transfers? If not, the divide between North and South becomes wider.

The coming years will see important shifts among the kinds of fuel consumed. The relative share of oil declines, as do the shares of coal and nuclear. Natural gas is the only form of primary energy to gain both in relative and absolute terms, clearly reflecting its reputation as a clean-burning fuel, especially in power generation. The relative share of renewables holds its own, disappointing perhaps to environmentalists, but nonetheless a victory of sorts.

What happens to all the energy consumed worldwide? A surprising 38% is burned to generate electricity. And 18% goes to fuel transportation, as does more than half the oil consumed.

We can define a number of oil trends, each a story in itself.

• European dependence on Gulf oil will remain significant.
• Asian dependence on Gulf oil will expand dramatically.
• U.S. oil imports will continue to grow.

And natural gas trends as well.

• Natural gas is the fastest growing primary energy source.
• Its use is to double, worldwide, by 2020.
• But this growth requires major infrastructure investments.
• The U.S. will become more reliant on imported natural gas.
• Russia, today providing 26% of the natural gas that Europe consumes, has its eye on expanding that share.

Coal does not enjoy the high visibility of oil and natural gas. Nonetheless, surprising to some, the United States is the dominant player, leading the world in coal reserves, in coal production and consumption, but likely will give way to China.

More than 55% of the coal consumed worldwide is for electricity generation, and in the United States, an even higher share -- around 92%. Electricity generation will be the basis for future growth in coal use, worldwide.

The nuclear future, unfortunately, is not all that promising. Nuclear power presently accounts for 16% of worldwide electricity generation. But by the year 2020 that contribution is expected to decline to just 10%.

The potential for renewable forms of energy is almost unlimited, but realization of that potential is constrained by costs and by technological limitations. The attraction of conventional forms of energy will be difficult to overcome, and scattered niche markets will likely remain the near-term future for renewables.

Electricity is the most rapidly growing form of energy use during the years up to 2020 at least. This growth will be concentrated in the developing countries, where electricity use will more than double. Why so? In the words of the former Chairman of Texaco, Peter Bijur, "wherever satellite dishes and cell towers sprout over mud, brick, or thatched roofs, people are coming to demand this consumer lifestyle as an entitlement."

Mutual Dependence between Exporters and Importers
Mack McLarty, former White House Advisor, speaking at a CSIS energy conference several years ago, captured the essence of energy globalization when he noted that: "When a Brazilian brews her morning coffee today, she is likely to use electricity from a power plant in Uruguay that runs on natural gas from Argentina provided by a Chilean company. She drives to work in a Ford fueled with Venezuelan gasoline, and her Canadian-owned factory may soon be powered by a 2,000 mile natural gas pipeline from Bolivia."

Exporters, for their part, work to assure importers that their needs will be taken care of. The Minister for Petroleum and Mineral Resources of Saudi Arabia confirmed that when he stressed at this same conference, that "regardless of crisis, disruption or sudden surge in demand, the Kingdom stands ready to respond." That promise holds true today, and is revisited whenever the adequacy of oil supplies is challenged.

Politics -- Energy
The media seems to take particular pleasure in highlighting stories that ask the question: are we in danger of running out of oil anytime soon? My answer to that question is, no, we are not.  In my judgment, world demand for oil likely will decline before physical limits on oil supply come into play. Moreover, currently known reserves of coal, natural gas, and uranium are not regarded as factors that might limit future production levels.

We may talk about the power of oil, but have we ever stopped to consider just what that power embraces?  Oil fuels much more than automobiles and airplanes. Oil fuels military power, national treasuries, and international politics. It is no longer a commodity to be bought and sold within the confines of traditional energy supply and demand balances. Rather, it is a determinant of well being, of national security, and international power for those who possess this vital resource and the converse for those who do not.

In the world of oil, perhaps the key question remains: Who can produce what? In other words, will the coming two decades anticipate any major shifts in production capacity amongst individual countries?

No shifts are anticipated. When the year 2020 rolls around, Saudi Arabia is projected to be in the lead, followed by the former Soviet Union, with Iran, Iraq, and Venezuela each holding a comparable share of the estimated world total, and Nigeria standing in sixth position.

But key vulnerabilities could well interfere with that role: external threats, leadership transition, economic reform and diversification, terrorism, and unemployed youth. In this latter regard, it is astonishing to note that 38% of Saudi Arabia’s native population were born after the Gulf War.

Iran presents a slightly different picture. While it too faces economic pressures and population growth, it also must confront limited investments in oil and gas export capacities. The need to deal with two governments--one popularly elected; the second, the force represented by its religious leaders -- hampers both political and economic relations with the outside world. And, of course, there is the matter of U.S. unilateral economic sanctions imposed on Iran.

Iraq today is an economic basket case, with UN sanctions constraining the oil sector. Current oil output levels will likely hold if sanctions remain. If and when removed, how quickly the health of the oil sector can be restored will become the issue.

Contributions of Venezuela to world oil supply have been declining under President Chavez. The oil sector is badly in need of substantial capital infusion, but oil earnings are diverted elsewhere, with little or nothing returned. Moreover, recently imposed laws discourage new foreign investment. Strikes immediately preceding the attempted coup had led to reduced oil production and export levels, and somewhat damaged the long-held judgment that the Western Hemisphere oil supply was inarguably secure.

Fortunately for Nigeria and Angola and for world oil markets, deepwater exploration prospects are good, and provide the basis for further substantial growth in output. Yet investments continue to be hampered by corruption and poor governance.

The Russian Role
We can now turn to Russia, surprising to some the number two oil producer and exporter in the world. Yet, it is quite a comedown from earlier glory days, when as late as 1988 Russia was leading the world in production, at 11.5 million barrels per day, easily surpassing Saudi Arabia. A handful of years later, production had fallen to just 6 million barrels per day.

Ruble devaluations in 1998, coupled with the sustained rise in world oil prices, provided the Russian oil sector with the incentives needed to turn the industry around. By 2001, oil production had risen to 7 million barrels per day, with the prospect of reaching 8 million barrels per day or more by the year 2005. But the crystal ball grows cloudy beyond that year. We are not yet sufficiently certain that production growth can be sustained.

Nonetheless, because domestic requirements show little change, most of the coming incremental production will become available for export.

Does Russia have the potential to return to production levels matching those of the mid-1980s?

• The geologic potential is there.
• The answer is yes, if Russia, the EU, and the United States want it to happen;
• if Russia improves its investment climate; and
• if foreign investors respond, and that means the world oil market must be of sufficient attraction to offset the risks of doing business in Russia

Russia holds 32% of world natural gas reserves; it leads the world in gas production and in gas exports. Over the years Russia has been a reliable supplier to European markets, and has been careful not to play politics with these exports. This image is especially important and continues to be polished as Russia contemplates further expansion in exports of oil and gas.

Yet, what to make of the recent statement by President Putin, warning Europeans that their energy dependence on Russia could create obstacles if Moscow was not treated as an equal partner in future agreements?

Caspian and Central Asia
Finally, we come to the much-publicized Caspian and Central Asian oil potential. What would an objective assessment tell us?

• It would tell us that the Caspian and Central Asia have been victims of media hype.
• The region cannot be viewed as a substitute for Persian Gulf oil. Rather, it is the equivalent of another North Sea. But then, that equates to a production level of 5 to 6 million barrels per day.
• By the end of this decade, this region probably will be providing between 3% to 3.5% of world oil supply.
• Not pivotal by any means, but important at the margin.
• And important for those oil-importing countries that seek security of supply through diversity of supply.

With OPEC reasonably successful today in manipulating oil supply in an effort to hold prices within a particular range, the thought had occurred to some that Russia, plus Azerbaijan and Kazakhstan, together might challenge OPEC at some time in the future.

Even under the best of circumstances, that challenge would fall considerably short. The oil future will be defined by the measure of oil reserves, and OPEC oil reserves far exceed those of the former Soviet Union.

Seeking Energy Independence
We all are aware that the United States imports some 57% of its oil supply and that we work to gain security of supply through diversity of supply. Are we successful in that regard? Not too bad. What countries then make up the top five, in terms of oil exports to the United States? In order, it is Canada, then Saudi Arabia, followed by Venezuela, then Mexico, then Nigeria. These five suppliers taken together provided some 62% of our oil imports in 2001.

By the way, Iraq was the sixth leading oil supplier to the United States during 2001. We imported almost 800,000 barrels per day from Iraq and refined that oil, producing considerable volumes of jet fuel. Some of that jet fuel was used by our military aircraft in bombing runs over Iraq, thus returning Saddam Hussein’s oil to him, but in a slightly different form.

Our political leaders often speak of the need to seek energy independence. But, is U.S. energy independence a political fantasy, given the high levels of dependency on imported oil and natural gas?

Might we want to consider adopting the approach taken by the European Union? This grouping of nations is far more dependent on imported energy than the United States, but officials do not speak of attaining energy independence. Rather, the approach taken has been how best to manage the risks associated with such dependence.

U.S. consumers are a funny lot. They really do not care where their energy supplies come from. U.S. consumers have just two concerns, and energy independence is not one of them. But price and availability are daily concerns.

Oil is truly a global commodity, and that means we are vulnerable to any event, any time, anywhere, that impacts on supply or demand. Thus, vulnerability is ever present, regardless of the level of import dependency.

Understanding Tradeoffs
Each incoming administration, it seems, sets out to develop an energy policy for the United States. Many, if not most, end up on the bookshelf, gathering dust. What does it take to be able to develop an energy policy? I would suggest that understanding tradeoffs is key to a successful U.S. energy policy and, indeed, for any country.

Every energy decision we make has a tradeoff and these tradeoffs carry their own risks and costs. Just what is meant by a tradeoff? Let me offer the following.

• Roughly 50% of the fuel burned in U.S. nuclear power reactors originates with Russia. These reactors in turn provide 20% of U.S. power generation.
• Doesn’t that put the United States in a particularly vulnerable position?
• Is there a tradeoff to justify this vulnerability?

There is. The Russian fuel for U.S. nuclear power reactors comes from the conversion of nuclear warhead material. This conversion at last count had eliminated the equivalent of 5,487 Russian nuclear warheads.

• The United States has traded a certain degree of energy vulnerability for a reduction in the Russian nuclear threat.
• This is an acceptable tradeoff, in terms of U.S. national security interests.

Non-governmental Organizations and Sanctions
Let us now turn to two diverse but equally important issues: first, the impact of non-state actors; and second, multilateral and U.S. unilateral economic sanctions. These issues may be related, in that efforts by non-state actors in the past have led to the imposition of unilateral economic sanctions and this success has not gone unnoticed.

As CSIS senior advisor Luis Giusti has noted, companies are going to have to face a different world, a world in terms not only of economics and return and economic prosperity, but also another category such as social justice and environmental quality.  We are aware of course of terrorism as a threat to the physical energy infrastructure and cyberterrorism as a threat to operating infrastructure, with both threats clearly within the capabilities of non-state actors. But we pay less attention to non-state actors usurping the decision-making role held by governments and the private sector.

Diverse actors -- e.g., Global Witness, Save The Children, Transparency International, and Tearfund-- are coming together today, for example, to seek full disclosure of payments to national governments by international oil companies, as a necessary precondition to development. Moreover, minimum standards of disclosure would be sought for all major players for all their countries of operation. Unfortunately, transparency must embrace both the paying companies and the receiving governments if the purpose of the effort -- eliminating corruption -- is to be successful.

The United States presently imposes unilateral economic sanctions on four oil producing and exporting countries:

• Libya
• Iran
• Syria
• Sudan

Together these sanctioned countries produce about 5.8 million barrels per day. It is perhaps time to ask -- have our sanctions been successful? Have these sanctions bought about the desired changes in the targeted country?

Unfortunately, there is no real evidence that they have.

Another question arises. Have these sanctions instead depressed oil production and export levels, thus contributing to higher market prices?

Here, there is evidence that they have, but at the same time host country policies, policies that do not offer particularly attractive investment terms and conditions, must equally share the blame.

In sum, practice has shown that nearly all unilateral sanctions fail nearly all the time.

Unfortunately, sanctions are like taxes. Once imposed, they are difficult, if not impossible, to remove.

Energy -- Geopolitics
A question that concerns both producers and consumers: Where is the world oil future to be found?  The answer: the future will not be found in current oil production levels. Rather, the future will be found in oil reserve levels. Which countries possess the greatest oil reserves?

Just four countries -- Saudi Arabia, Iraq, Iran, and Russia -- together control almost 70%, that is, 7 out of every 10 barrels, of world oil reserves. That is not particularly reassuring of future oil supply and price stability.

The United States today accounts for some 19.6 million barrels per day of total world oil consumption of 76 million barrels per day. Thus, how we satisfy that demand impacts on oil worldwide. Because we have become so dependent on imported oil to cover our demand, our key concern is energy supply reliability. We have responded to that concern in a number of ways.

• By maintaining U.S. defense capability.
• By encouraging burden-sharing to protect supply.
• By placing emphasis on tension-reducing measures, including collaborative energy infrastructure projects.
• By working to protect critical infrastructure.
• By maintaining and expanding our Strategic Petroleum Reserve, which today holds roughly 560 million barrels, with an effort under way to expand that level to 700 million barrels.
• By promoting diversity of supply and transportation routes.

The best example of this latter effort is the policy we have adopted in support of Caspian and Central Asian oil development. That policy could be defined, with tongue-in-cheek, as "happiness is multiple export pipelines, all running in the same direction, and all bypassing Iran."

As a consuming country, what can we do to help expand energy availability?  Above all, we must recognize existing contradictions in our policies and as well the political and economic importance of key producing countries. We must re-assess our sanctions policy. And we must continue to fine-tune our policy in the Caucasus and Central Asia. We must encourage China to diversify its energy sources, both for environmental and for supply security reasons. Finally, we must encourage market reforms in those countries where supply-demand decisions rest with bureaucrats.

We will all benefit if developing countries have access to adequate, timely, and secure sources of energy. At the same time, a rapidly industrializing South, in its judgment, cannot afford to place environmental policy ahead of economic growth. And that raises the prospect of a divisive North-South controversy.

What is needed if we are to respond successfully to the still highly contentious and broadly debated issue of global warming? Sir Winston Churchill provided an insight into how matters might work out when he said, "Americans can always be counted on to do the right thing, after they have tried absolutely everything else."

Developing countries are apt to consider nuclear power as a viable option, especially as a way of providing electricity in rural areas and as a basis for promoting general industrialization. But if nuclear power is to be offered as an option to developing countries, then it must be maintained as an option for developed countries.

In the end, if the nuclear option is not exercised -- and that will require government support, as the market itself won’t do it -- then pollution will worsen.

Renewables
Interest in expanding the role played by renewable forms of energy peaks on two occasions, sometimes exclusive, sometimes linked: when oil supplies out of the Gulf are threatened, and when oil prices spike.

Shell International, in a recent study, found that worldwide renewable energy sources could adequately meet the energy needs of 10 billion people. Unfortunately the path to meaningful employment of renewables is not as easy as it may appear. Local resistance to large-scale wind firms will emerge; biomass will face land use limitations; wind and solar power progress will be constrained by energy storage and grid reliability concerns.

But the impact on oil use will be very limited. Thus, we must look elsewhere if measurably reducing oil consumption and in turn oil imports is our goal.

That of course takes us to the internal combustion engine. Can we say goodbye to the internal combustion engine? Perhaps, but in the United States it will be a long goodbye. Americans buy about 17 million vehicles annually. There are 200 million vehicles on the road today, and the gasoline these vehicles consume accounts for some 45% of total U.S. oil consumption. To put all this in a slightly different perspective, our gasoline consumption alone represents almost 12% of total world oil consumption. Because of that, what steps we might take to influence our gasoline use holds important implications for the world oil market.

What eventually will replace the gasoline engine? Very likely, hydrogen-based fuel cells, where hydrogen and oxygen combine to produce electricity and water. That water would be the only vehicle emission. The challenge facing the manufacturer is obvious: To succeed both in the laboratory and in the market place.

So, What’s New?
As we look down the road, trying to define an energy future acceptable to all, what do we find?

• The influence of non-governmental organizations (NGOs) on energy-related policy decisions is seen as expanding.
• Developing countries take the lead in energy consumption.
• Very real prospects of terrorist attacks on our energy infrastructure.
• Global warming is attracting growing attention.
• Regarding security of supply, if U.S. military power were committed even to an extended protection exercise, say in NE Asia, the capacity to respond to a crisis like that of 1990 in the Gulf would be severely limited.
• We are confronted with two policy contradictions:

• The future need for oil is at odds with current sanctions on Libya, Iraq, and Iran. If our estimates of future world oil demand are reasonably correct, then these countries will have to be producing and exporting at or very near capacity, if that demand is to be satisfied.
• The United States deals with its energy policy in domestic rather than international terms, which puts that policy at odds with globalization.

Troubles ahead? To be sure. Where is the growth in energy demand coming from? Unstable countries. Where is the growth in energy supply coming from? Unstable countries. All this makes for a somewhat uncomfortable and unpredictable future.

Let me leave you with this final thought:  Our assessments stress the prospects for instability and interference in energy supplies. But we have taken this approach only to alert policy-makers as to just how fragile timely energy supplies really are.